Stefan Karlsson's blog

Hard-Hitting Economics Commentary

Saturday, February 27, 2010

The Effects Of Labor Unions

Tino Sanandaji has an interesting post, where he points out that the share of national income (or total factor costs) going to labor is roughly the same in countries where labor unions are strong and in countries where unions are weak. So unions do not seem to redistribute from capital to labor, as their retoric would have you believe.

Does this mean that union actions have no effect? No, it doesn't mean that. Sanandaji correctly mentions one effect, namely to redistribute between different workers, but he doesn't elaborate upon this except to hint that the redistribution occurs when other workers face higher prices. That is true as far as it goes, but incomplete, which is why I will elaborate on the subject.

To understand the effects of unions, imagine a situation where we go from very strong unions, to powerless unions, and that at the same time no minimum wages or similar government regulations existed (the analysis around unions here can be applied to minimum wages as well). Would some employers then lower wages for some workers and/or replace their current workers with other workers willing to work for less? They almost certainly would in cases where they didn't believe this would have a significant negative effect on productivity and where there would still be workers available that would be willing to work for them. This means initially that profits would increase and labor income would drop. But how can this be squared with the above finding that unions do not redistribute between capital and labor?

Simply because the story doesn't end there. If profitability were particularly high in some sector than this would attract increased investments from other firms, helping to bid up wages and push down prices until the excess profitability was removed. Or alternatively, the capitalist may find that while profits are up now, the cheap labor means that profits could be increased further by expanding volumes by lowering prices, something which would mean that more workers would be hired and consumer purchasing power would be increased. However in this case, while the absolute level of profits would increase due to higher volumes, lower profit margins would decrease profit margins and the relative share of income going to capital.

We can now see that one effect of the disappearance of union power would be to increase real output and reduce unemployment. This of course implies that union power results in lower real output and higher unemployment.

But if union power results in no increase in relative income for labor and a decrease in the absolute level of income (especially if you also take into account the cost of strikes and other union activities), why would anyone want to unionize?

Well, in many cases unionization is as irrational as it seems at this point. But usually unionization is driven by a desire to increase relative income for unionized workers compared to other workers. In the case below where union power disappeared, even though average income is up, income for the weakest workers would likely go down, even after taking lower prices into account.

Note that this improvement in relative income for some will have to apply to all workers in unionized sectors, even for workers who aren't union members. There has been many cases where unions have fought hard to raise wages at companies where not a single worker is member of the union. This was for example the case with the case of Latvian construction company Laval that had gained a contract to build a school in Stockholm suburb Vaxholm in 2004 using Latvian workers that were paid Latvian wages. Even though none of the workers were members of the Swedish construction worker union Byggnads, Byggnads still insisted that everyone should receive the same pay as Swedish construction workers. And when Laval refused to agree to this, Byggnads in collaboration with other unions, blockaded the project, making it impossible for Laval to finish the job.

Why did Byggnads do this? Because they altruistically cared about the Latvian workers? Hardly, especially given the "go home" chant Byggnads activists shouted to the Latvian workers. Instead, the reason why Byggnads and other unions insists that even workers who aren't members of their unions should receive the same pay is because they fear on good grounds that if other workers receive a lower pay than companies will hire them instead, and that companies that continue to hire union members will be out-competed.

One example of what happens when not all workers in one sector receive the same pay as union workers can be seen in the case of the Detroit car industry, which has been increasingly out-competed by Japanese and other foreign car makers hiring lower paid non-unionized workers in the South and elsewhere. Unions can only raise the relative wage for their workers if they are able to block competition from other workers. If they fail to do so, their members will lose their jobs, just like in the case of the Detroit car industry.

The increase in relative wages caused by unions thus applies to all workers within a sector that work with the same tasks. The increase in relative wages is instead relative t other workers, both in completely different sectors and workers performing other tasks in the same companies. It is these other workers (including management that sees their income drop as a result of union actions. Also, the elevated wages attained by unions will also come at the expense of people who become unemployed because wages are higher than their marginal productivity.

Friday, February 26, 2010

Was U.K. GDP Revised Up Or Down?

If we are to believe the financial press version of the latest U.K. GDP report, U.K. GDP was revised up, with the quarterly growth number increasing from 0.1% (or 0.4% at an annualized rate) to 0.3% (or 1.2% at an annualized rate.

Yet if you look at the actual report, you can see that the yearly change was revised from -3.2% to -3.3%. The reason why the yearly change was revised down while the quarterly change was revised up was that the quarterly changes in previous quarter were much weaker, and as a result the absolute GDP level and the yearly change was in fact weaker than previously thought.

1) The trade deficit can increase (and it has in fact done so in America since the "stimulus bill" was passed in February 2009), meaning that some of the increase in domestic demand will benefit foreign producers instead of domestic producers. Because the flip side of an increase in the trade deficit (or more strictly the current account deficit) is an increase in net capital inflows, this will on the other hand limit the increase in interest rates. But the point is that the "crowding out" effect will appear as an increase in the trade deficit, not an increase in interest rates.

2) To the extent that consumers acts according to the theory of Ricardian equivalence, an increase in the budget deficit will cause consumers to restrict their consumption. On the other hand, a higher savings rate will limit the increase in interest rates. But the point is that the "crowding out" effect will appear as an increase in the savings rate, not as an increase in interest rates.

3) To the extent the Fed "monetizes" the deficit by printing money, this will raise prices. The indirect effect of the deficit in this case in the form of higher prices will reduce people's purchasing power, "crowding out" the direct increase in purchasing power created by the increase in the deficit.

It is thus very misleading (in addition, there is another problematic factor in the form of other factors which would have caused interest rates to go up or down regardless of fiscal policy) to look at interest rates alone as a guide to the extent of crowding out.

Increasing Signs That U.S. Recovery Is Losing Steam

Wednesday, February 24, 2010

Why Greece Won't Default

The Greek bond panic has been driven by two concerns: either that Greece will exit the euro and try to convert their euro bonds into "New Drachmas" (or whatever the reintroduced Greek national currency would be called). Or that Greece will default on its debt (and it is assumed, not repay their debts in full later).

It is possible, of course, but it is highly unlikely. And it is not an option with regard to escaping the necessary fiscal austerity measures.

Assume that Greece would default on its debt, and thus in effect say "screw you" to its creditors. Just who would then lend to them? I don't think anyone would, so Greece at that point would be cut off from debt markets (and also face massive law suits from creditors).

While Greece wouldn't have to pay interest or refinance bonds that reached maturity if it defaulted, it would still have a very large budget deficit, which would need to be covered by borrowing money. But if Greece defaulted, that window would be closed.

If Greece defaulted, it would in other words have to reduce its primary deficit (excluding interest payments) to zero immediately, which would require far more radical austerity measures than have already been proposed and implemented.

It is only when the primary balance becomes positive that default would become a potential way to solve cash flow problems of the Greek government. But that will likely not happen until at least two or three years from now, and since default would even then be associated with severe negative consequences and since the panic by that time will likely have been subsided, there is no reason to assume it will happen even then. Illustrating again why the current panic about Greece is largely irrational.

Hong Kong Confirms Asian Rebound

Hong Kong's GDP growth number confirmed the Asian rebound I have discussed the last two days. While growth wasn't as impressive as in Taiwan and Thailand, it was stiller a lot stronger than in just about all Western nations.

Compared to the previous quarter GDP rose 2.3%, or 9.5% at an annualized rate. Compared to a year earlier, the gain was 2.6%. Yearly growth was primarily driven by increased private consumption (+4.9%) and increased investments (+14.7%). Government consumption increased slower (+1.7%) while the trade surplus fell.

Hong Kong's unemployment rate peaked at 5.4% in the May-July period of 2009 while the underemployment rate (which is people who work part-time, but would prefer to work full-time) peaked at 2.4% in the same period. In the November 2009-January 2010 period, the unemployment rate had dropped to 4.9% while the underemployment rate had dropped to 2.2%.

Tuesday, February 23, 2010

Freezing Weather Freezes Economies

Last month, I told you about how unusually cold weather was a factor increasing the probability of a "double dip" recession in the U.K.

Now we are seeing more examples of how the cold winter in the northern part of the northern Hemisphere is reducing economic activity.

The U.S. payroll employment number for February will likely be negatively affected by the blizzards that struck much of the North East United States, while the German ifo-index fell as cold weather reduced both retail sales and construction activity. Meanwhile, much of the Swedish rail system (and to a lesser extent some car/truck and air traffic) was paralyzed by extreme cold and large amounts of snow, something which will likely negatively affect many business activities.

If only we had more "global warming"....

Aside from that, another interesting observation one could make is that this makes "seasonal adjustments" more problematic. While I think "seasonal adjustments" makes sense in principle (assuming the absence of below mentioned practical problems), it is often a lot more problematic than many people think in practice applied to actual statistics.

Here we have a clearly seasonal (in the northern hemisphere, cold- and snow related problems only arise during the last and the first months of the year) factor depressing economic activity, yet because the severity of this seasonal factors varies from different years, the standard statistical method of historical averages will easily become misleading. If it was possible, one should let the factor vary from different years instead, but the risk is that this could allow statisticians to make arbitrary judgments, possibly influenced by political factors. Finding a way to objectively assess the different seasonal effect each year is something which aspiring statisticians should think about.

The Great Asian Rebound

Dean Baker is right to note that New York Times misleads its readers (I however personally thinks it is likely unintentional so I wouldn't use the word "deceive") when they write that Thailand's GDP rose 3.6% in the fourth quarter. Since New York Times is an American news paper they should use the American way of expressing growth, which is to say that they should in this case write that Thailand's GDP grew 15% at an annual rate.

This means that while the rather dramatic drop in demand associated with the panic following Lehman's collapse did disrupt the Asian economies as the drop in demand was unexpectedly large and sudden and as it takes time to re-organize factors of production, they have been successful in reducing their dependence on net exports to the West and instead re-organize the factors of production for the purpose of domestic demand (for Asia as a whole).

Meaning that they can now themselves use the products they produce instead of sending them to the West, and get securities of dubious value in return. As I wrote two years ago, this means that the value of their production will be higher, just like Americans were better off after World War II ended despite the fact that official GDP fell. Even if you grant that the massive military expenditures during World War II was necessary to destroy the threat from Imperial Japan and Nazi Germany, military expenditures didn't represent real wealth, meaning that the decline in GDP was misleading. Private consumption and investments did in fact soar after the end of the war, meaning that real wealth increased. Similarly, current output in Asia arguably represents more genuine wealth than the one represented by the accumulation of dodgy Western securities.

Monday, February 22, 2010

Leftist & Rightist Deficit Hypocricy

Many people, including me, have accused Paul Krugman of being a hypocrite on the issue of government budget deficits.

Back when Bush was president, he kept attacking Bush for his deficits, yet now that Obama has become president, he keeps defending the far bigger deficits that Obama is presiding over.

Note that this is not simply a matter of Krugman saying he prefers increased deficits compared to spending cuts, but not compared to tax increases.

Many free market advocates would similarly say that while deficits are bad, tax increases (or the absence of tax cuts) are even worse. Which is why they therefore would reject a fiscal austerity plans consisting entirely or primarily of tax increases, while welcoming a plan consisting entirely or at least primarily of spending cuts. If it was merely the case that Krugman with his opposite political preferences viewed a budget deficit as a lesser evil compared to spending cuts, but worse than tax increases (or the absence of tax cuts) that would be at least logical given his political preferences.

No, the point is that Krugman now not merely says that deficits are a lesser evil compared to spending cuts (or the absence of spending increases) , he denies that deficits are problematic at all, whereas he under the Bush presidency argued that any serious economist would recognize that deficits have negative consequences.

Krugman, however, isn't the only hypocrite, of course. Many other leftists have similarly "flip flopped" on the deficit issue. And it should be added, many "rightists" have "flip flopped" from denying that deficits could ever be a problem to now being deficit hawks that warns that the deficit is a big problem. They could however at least point to how the deficit is much bigger now than when they defended Bush's deficits.

Another case of rightist deficit hypocrites consist in rightist euro skeptics arguing that while fiscal discipline is good for America, it is bad for Greece.

One example of this is American Enterprise Institute fellow Desmond Lachman who have previously argued that there was no reason to believe that Obama's "stimulus package" was working.

Similarly, Arnold Kling hinted that Keynes could be right regarding the effects of fiscal austerity in the absence of devaluations, even as he has repeatedly (for example here) against Obama's stimulus. Also, Johan Norberg, similarly claimed (in Swedish) that deficit reduction measures will curt the economy, even though he has repeatedly argued (for example here) that fiscal stimulus won't work.

Just as in the first examples, this wouldn't necessarily be hypocritical if the distinction between tax and spending changes to achieve fiscal austerity or stimulus was emphasized. But in none of those cases it was, instead it was said that fiscal discipline by unspecified means were good in the case of America, while bad in Greece.

But what of the argument offered explicitly by Kling, and hinted by Lachman and Norberg, that the difference is that America can debase the value of its currency, while Greece can't? That argument doesn't hold at all, because even assuming for the sake of the argument that devaluations are good, America can't devalue its currency given the current situation and using the policy means it now uses.

With its floating exchange rate policy, America doesn't directly control its exchange rate and can't lower it in response to fiscal policy changes. The only way you could lower it under a floating exchange rate policy (America could of course also try direct currency market interventions, but that would represent a departure from the floating exchange rate policy) would be to lower its policy interest rates. But America can't do that since they're already almost zero, so for all practical purposes America is in the same situation as Greece right now.

Which means that either you must assume that the Keynesian policy analysis is correct, which would mean that Krugman is right in arguing that Obama's “stimulus” policy has boosted the economy. Or you must assume that the Keynesian policy analysis is incorrect, which would imply that Greek fiscal austerity is good. You can't both hold the position that the Obama stimulus is bad and that Greek fiscal austerity is bad.

Taiwan's Rapid Recovery

"Russian components, American components-all made in Taiwan!", so said the Russian cosmonaut Lev Andropov (played by Swedish actor Peter Stormare) in the 1998 movie Armageddon in reply to the comments by a female American astronaut that he didn't know the components.

That was and remains a great exaggeration of course. Many, and probably most components are made outside of Taiwan, but it seems that more and more of them in terms of absolute quantities (though not necessarily in terms of market share) as well as other products are made in Taiwan.

Taiwan's GDP rose as much as 8.5% compared to a year earlier in seasonally adjusted terms and 9.2% in unadjusted terms. Compared to the previous quarter it rose 4.2%, or 18.0% at an annualized rate.

Bloomberg in its version claims that only now did Taiwan exit the recession, because only now did the yearly change turned positive, but usually the criteria for this is when the quarterly change turns positive, and the quarterly change turned positive already in the second quarter.

Not only has Taiwan exited the recession, it has in fact now recovered the entire loss in output during it, so that real GDP is slightly higher now than the previous peak in output reached during the first quarter of 2008. By contrast, while America, Japan and the EU has all recovered in the sense that quarterly change has turned positive, the absolute level of output remains below the peaks.

The main cause of Taiwan's recovery is the boom in neighboring mainland China. While political relations are still frosty (and turned even frostier after Taiwan recently bought advanced military equipment from America), trade and investment relations have increased dramatically, causing higher growth in both countries, and making war less likely.

Another reason for Taiwan's boom is its low tax and low government spending (only about 18% of GDP) policies.

In the long run, the extremely low Taiwanese birth rate (the fertility rate is only about 1 child per woman, even less than in the mainland or in Japan, and much less than the 1.5 to 2 fertility rate in most Western countries) is a threat to economic growth, though that won't be a significant problem for at least another decade and can be limited by immigration from for example the mainland.

I was well aware of this idea, as Ambrose Evans-Pritchard recently advocated it. I didn't address it because for one thing I thought that the post was on the verge of becoming too long, and because it is completely unrealistic, in many ways even more so than the scenario of the weak countries leaving.

First of all, the practical difficulties would be virtually as large. Assuming German deposits and bonds would be converted into New Marks, then this too would create a run against the financial systems in the rest of Europe. Why would anyone want to hold accounts or bonds in the rest of Europe if they're practically guaranteed high returns (the whole purpose if this operation is to raise the value of German currency) if they hold German accounts or bonds?

This problem could be eliminated if German accounts and bonds remained denominated in euros even after the introduction of a "New Mark" (or whatever the new currency would be called). But that would create other disruptions. Just as domestic currency depreciation is bad for borrowers with foreign currency debts, domestic currency appreciation is bad for creditors with foreign currency debts. German savers and banks would suddenly lose much of their assets as they drop in value along with the euro. And this wouldn't be limited to just assets in Germany, their holdings elsewhere in Europe would also lose value. The effect for German savers and banks would be a partial default on all of their fixed income assets, creating much more trouble for them than if Greece or some other state had a partial default.

The second big problem is that there is absolutely no reason why Germany would want to do so. Germany is not under any market pressure, quite to the contrary as their bonds have gained "safe haven" status within the euro area. While they could possibly maintain such a status, some of the safety for other euro area residents consists in the lack of exchange rate risk, something which would go lost if Germany had a separate currency. And with an independent currency, "safe haven" status will mean that the value of your currency will be driven up, causing disruptions and problems for your exporters. This could partly be compensated in the short term by the reduced debt burden for the German government, but because the value of the safe haven status would be significantly reduced, and because of the losses for German investors in other parts of the euro area, this gain will be much smaller than the losses for German investors.

Furthermore, this scheme would greatly damage the German export industry, both because of lost exchange rate stability and because of the higher value, causing great job losses in Germany. The 43% of German exports goes to and 46% of German imports comes from the rest of the euro area (with a few more percentage points being with Denmark and others with fixed exchange rates to the euro)would suffer the most, but as the "New Mark" would probably appreciate against other currencies as well (though probably by less than against the euro as the euro would presumably depreciate), exports to other parts of the world would also decline.

Why should Germany even consider such a scheme given the damage it would inflict on both its financial sector and its foreign trade? There is no way Germans would want to make such large sacrifices just because it would allegedly help foreigners with fiscally irresponsible governments.

Some might say that they would do so because they don't want to bail out these other governments. But that doesn't hold. First, because the proposed scheme would itself be a form of bail-out, and a very costly one for Germany. And secondly, there is nothing in EU treaties that compels Germany to bail out the governments of other euro area countries. EU treaty in fact explicitly forbids the ECB or the EU from doing so, and any bail-out would therefore have to carried out directly by other national governments and that would be voluntary for them.

Germany is unlikely to agree to any hand-outs (as in gifts) to Greece or others. And any loans would likely come only if Germany felt it would be beneficial to them, for example if they got paid say two percentage points in premium compared to Germany's own cost of borrowing (under such a "bail-out", Germany would thus actually earn money) and were also coupled with increased external supervision and the implementation of further fiscal austerity measures.

In short, the idea that Germany would exit is even more unrealistic than Greece exiting, because it would be more obviously damaging to the country that is supposed to leave.

Saturday, February 20, 2010

Excluding "Equivalent Rent", Core Inflation Is Up

Many analysts, and also Wall Street which escaped the sell-off that the Fed's discount rate increase otherwise would have caused, made a big deal out of the small drop in so-called "core inflation" in America in January. However, that was likely a blip caused by temporary factors.

However, what few have noticed is that this is entirely the result of a big drop in the rate of increase in rents and "owner's equivalent rents". Indeed, excluding this factor, "core inflation" has risen significantly.

Rents are about 7.5% of the "core" index, while "equivalent rent" is 32.5%. In the year to January 2009, rents increased 3.4% and "equivalent rents" increased 2.2%. In the year to January 2010, these increased had dropped to 0.5% and 0.4% respectively. Excluding these factors, "core inflation" was 1.2% in the year to January 2009 and 2.35% in the year to January 2010.

One example of this was apparel prices, which decreased 0.9% in the year to January 2009 but increased 1.7% in the year to January 2010.

Now, I really don't believe in the "core inflation" concept, so I wouldn't make much of this increase in what one might call "core core inflation". I do however consider the increase in all-items inflation from 0.0% in January 2009 to 2.6% in January 2010 to be of interest. The point is instead that particularly given how rents and "equivalent rent" is affected by relative preference for owned housing relative to rented housing and given how they have such a big influence on the "core" index, one shouldn't make much of the movements in "core inflation".

Friday, February 19, 2010

U.S. Dollar Strength Will Reduce U.S. Corporate Profits

During much of the stock market rally, one factor driving the rally was the weak U.S. dollar, which was likely to boost corporate profits both by increasing margins or competitiveness of U.S. exporters and by increasing the dollar value of the profits of foreign subsidiaries of U.S. companies (while higher import costs for U.S. companies would partly offset this, the net aggregate effect was clearly positive).

Now that the U.S. dollar has again started to rally this will negatively affect corporate profits. As the rally has been particularly strong against the euro (+12% from the November lows) and the pound (+9%) and as euro area and the U.K. aren't among the biggest trade partners, but do have large domestic markets where subsidiaries of U.S. multinationals earn much of their profits, the negative effect will mainly come in the form of reductions in the dollar value of the profits of foreign subsidiaries.

The markets haven't appeared to notice this yet, but ultimately they will as profits falls as a result.

What Does The Fed's Discount Rate Increase Mean?

The direct effect is neglible. The discount window is used so rarely that a discount rate increase won't have any effect on real world interest rates worth mentioning.

However, as the market reaction illustrates, this increase will have the indirect effect of increasing expectations that the Fed will increase the rates that really matter -the Fed funds rate and the interest that the Fed pays on bank reserves- sooner rather than later.

While the Fed claims that this is meant to normalize the spread between the funds rate and the discount rate, and that they intend to keep the funds rate low for an extended period, and while this may actually be true, many people will nevertheless interpret this as a signal that the more important rates will be raised sooner than people earlier thought, something which will increase bond yields, and thus have a tightening/deflationary effect. The effect will however probably only be very small.

Thursday, February 18, 2010

The Spanish Reversal

Contrary to what you may believe when reading Paul Krugman and many others on Spain, Spain has actually had a relatively moderate drop in output during the latest crisis. Of the four other major Western European economies, only one (France) has had a smaller drop in output, while the other three (Germany, Italy, the U.K.) have had bigger drops in output.

While the drop in domestic demand has been bigger than elsewhere, this has been largely compensated for by a big drop in the Spanish trade deficit.

Yet if you look at unemployment, Spain has fared worse than other Western European countries, much worse in most cases in fact. It has the highest unemployment rate in Western Europe and has also seen the biggest increase (in percentage points).

How can this discrepancy be explained? While it is possible that there might be some statistical error (with either the Spanish drop in output being underestimated or the Spanish drop in employment being overestimated, or both), the main cause is that productivity has increased faster than elsewhere.

But haven't we often been told that Spain has a problem with productivity? Yes, we have, and while that was true in the past, it hasn't been true recently.

If you look at the more detailed national account numbers released today, you can see that nominal GDP has dropped 2.8% (nominal domestic demand is down 7.6%, the difference being of course the result of a big drop in the trade deficit) in the latest 2 years, while the domestic demand price deflator is down 1.5%, implying a cumulative 1.3% drop in the real value of output.

Yet employment has dropped as much as 9.1% in two years, with the job losses being particularly dramatic in the construction sector, where employment has dropped as much as 34.5%.

This implies a productivity increase of more than 8% in 2 years. Meanwhile, compensation per employee increased more than 10% in real terms, the difference being accounted for by stagnating profits and a sharp drop in net taxes on production and imports. So, while employment has dropped dramatically in Spain, average real wages for those that have been able to hold on to their jobs have soared.

The current story of rapid increases in productivity and rapid drops in employment contrasts with the opposite story during the boom years when employment grew rapidly, while productivity dropped.

The most likely explanation for this is that during the boom, labor supply increased rapidly due to massive immigration (and to a lesser extent an increasing number of women entering the work force). However, since the new workers had lower productivity than the male native born Spanish workers, output increased a lot less than employment.

With the bust, that hit the construction sector (where low productive foreign workers were over represented) disprortionately hard, causing unemployment to increase. While employment of native born Spanish workers dropped 5.1% in the latest year, employment of foreign workers dropped 11.75%. The unemployment rate of foreigners have now reached nearly 30% (compared with 16.8% for Spaniards). Because job prospects remained dismal in their countries of origin, few have wanted to return.

So, Spain had for years a boom with particular emphasiz on low productive foreign workers in the construction sector, causing it to have higher growth in employment than in GDP, but now the current bust partially reverses this, as these low produtive workers disproportionatelly loses their jobs, causing employment to drop more than output.

U.K. Posts First January Deficit

Traditionally, the British government has a large surplus in its finances in January as January is the time when corporations make a large part of their tax payments. In January this year the surplus was only £1.2 billion, down from £10.2 billion, reflecting both a big drop (7.6%) in revenues and a big increase (9.8%) in spending. If you take the high inflation rate into account, the drop in government revenues were even greater while the increase in spending was smaller.

And it is even worse if you use the normal accounting principles for government finances. The U.K. government has the unusual principle of not counting spending it calls investments as spending, despite the fact that these "investments" do not generate any visible return for the government. If you had also included borrowing for "net investments" (which most government accounts do), then the surplus of £5.3 billion in January 2009 swung to a deficit of £4.3 billion.

For the first 10 months of the fiscal year, the official deficit rose from £36 billion to £90.7 billion, while the deficit using normal accounting methods rose from £58.4 billion to £122.4 billion.

While government revenue is partly a lagging indicator, the fact that it keeps falling is clearly a sign that the recovery is very weak at best, something that is confirmed by other indicators as well (see here and here).

UPDATE: A British reader has sent in a clarification, pointing out that not all British companies sends in their taxes in January. This depends on what corporate fiscal years they have, something which British companies can freely choose. However, most companies choose the calendar years as their fiscal years, explaining the above mentioned calendar effect.

Wednesday, February 17, 2010

Right & Wrong From Eichengreen About Euro Area Breakup

Barry Eichengreen writes in a good way about the procedural problems associated with Greece or anyone else exiting the euro area. There have been many cases of currency areas’ breaking up in the past, but in those days capital was less mobile and/or the motive for doing so wasn't to lower the value of money.

"The insurmountable obstacle to exit is neither economic nor political, then, but procedural. Reintroducing the national currency would require essentially all contracts – including those governing wages, bank deposits, bonds, mortgages, taxes, and most everything else – to be redenominated in the domestic currency. The legislature could pass a law requiring banks, firms, households and governments to redenominate their contracts in this manner. But in a democracy this decision would have to be preceded by very extensive discussion....

...One need only recall the extensive planning that preceded the introduction of the physical euro.

Back then, however, there was little reason to expect changes in exchange rates during the run-up and hence little incentive for currency speculation. In 1998, the founding members of the euro-area agreed to lock their exchange rates at the then-prevailing levels. This effectively ruled out depressing national currencies in order to steal a competitive advantage in the interval prior to the move to full monetary union in 1999. In contrast, if a participating member state now decided to leave the euro area, no such precommitment would be possible.The very motivation for leaving would be to change the parity. And pressure from other member states would be ineffective by definition.

Market participants would be aware of this fact. Households and firms anticipating that domestic deposits would be redenominated into the lira, which would then lose value against the euro, would shift their deposits to other euro-area banks. A system-wide bank run would follow. Investors anticipating that their claims on the Italian government would be redenominated into lira would shift into claims on other euro-area governments, leading to a bond-market crisis. If the precipitating factor was parliamentary debate over abandoning the lira, it would be unlikely that the ECB would provide extensive lender-of-last-resort support. And if the government was already in a weak fiscal position, it would not be able to borrow to bail out the banks and buy back its debt. This would be the mother of all financial crises."

It could be argues that one way of getting around the massive capital flight would be to outlaw capital outflows during the discussion about exiting. But apart from the many practical problems associated with that, including the possibility of bank runs of people wanting to switch to euro notes, that would likely simply ensure that capital flight would happen during the discussion to introduce the controls.

Another way of getting around this problem would be to say that bank deposits and bonds would still denominated in euros. But that would create the problem of debt traps. If say the Greek debt burden is 105% of GDP, and a new drachma falls 30% in value, then the debt burden would immediately increase to 150% of GDP. If the drachma falls 50% the debt burden rises to 210% of GDP. It should be clear that with this solution, the debt problem of Greece wouldn't be solved. It would in fact likely get worse, just as the big devaluations of Ukraine and Iceland only worsened their debt problems. Trying to inflate your way out of debt doesn't work if the debt is denominated in a foreign currency.

While Eichengreen is basically right that the practical or procedural problems makes a euro area break up extremely unlikely (notwithstanding the wishful thinking from certain British and American pundits to the contrary), he is wrong about the economic pros and cons about an exit:

"the country would be forced to pay higher interest rates on its public debt. Those old enough to recall the high costs of servicing the Italian debt in the 1980s will appreciate that this can be a serious problem.

But for each such argument about economic costs, there is a counterargument. If reintroduction of the national currency is accompanied by labour market reform, real wages will adjust. If exit from the euro area is accompanied by the reform of fiscal institutions so that investors can look forward to smaller future deficits, there is no reason for interest rates to go up. Empirical studies show that joining the euro-area does result in a modest reduction in debt service costs; by implication, leaving would raise them. But this increase could be offset by a modest institutional reform, say, by increasing the finance minister’s fiscal powers from Portuguese to Austrian levels. Even populist politicians know that abandoning the euro will not solve all problems. They will want to combine it with structural reforms."

Assuming that the transition problems discussed earlier could somehow be solved (or assume that Greece had never entered the euro area), would exiting (or not entering) the euro area really make debt service more costly? Quite to the contrary under the current circumstances if the government issues debt in its own currency. The reason for that is that with your own central bank, you can have the central bank hold down interest rates by monetizing or threatening to monetize the debt. A comparison of Greece, which pays a real interest rate of 5% on long term securities, and the U.K which pays a real interest rate of 0.5% on its long term securities, despite the fact that the Greek and British deficits are equally large, illustrates this.

And Eichengreen is also wrong on structural reform. There is no reason at all to assume that Greek politicians would have been more willing to for example cut government spending if they could devalue and have a central bank partly monetize its debt. Quite to the contrary they would be a lot less likely to institute reforms resisted by government sector employee unions and others benefiting from the status quo. If there was little cost of borrowing more money then it would have little incentive to take the heavy political price of fighting government sector employee unions and others. It is only because of the current pressure from the bond markets that the Greek government has the political will to do so.

The Bank of England tries to pretend that it has nothing to do with this, saying the higher inflation rate was due to the reversal of the VAT hike, higher commodity prices and the weak pound.

While the Bank of England may not have caused the VAT hike that is a bad excuse since this hike was a reversal of the previous year's reduction, and inflation stood at 3% even after that cut. The same goes with commodity prices which had fallen significantly in the year to January 2009. Moreover, the Bank of England (like all inflating central banks) is partially responsible for the increase in commodity prices.

And blaming the weak currency is of course no excuse at all, since they are responsible for that.

For the Gordon Brown government, the high U.K. inflation is good, since it means that in real terms they borrow much more cheaply than almost everyone else, including Germany, despite running a deficit as large as that of Greece relative to GDP. There's nothing like having your own printing press for deficit spending politicians.

Monday, February 15, 2010

The High Japanese Real Interest Rates

After a stagnant third quarter, the Japanese economy again expanded during the fourth quarter. GDP grew by 1.1%, or 4.4% (terms of trade adjusted, unadjusted was only slightly higher at 4.6%) at an annualized rate, compared to the previous quarter. For the first time since 2008, nominal GDP also, grew, but only at an annualized rate of 0.9%. This means that price deflation was 3.5% at an annualized rate during that quarter, while compared to a year earlier deflation was 2.8%.

Japan thus bucks the trend among most advanced economies of rising inflation (With inflation being roughly 2.5% in the U.S., 1% in the euro area and 3% in the U.K.) and has persistent deflation.

Because inflation has returned elsewhere and because nominal interest rates are close to zero almost everywhere else except Australia and New Zealand, Japan has thus much higher real interest rates than other countries. The real short term interest rate is almost 3% in Japan, far higher than 0% in the euro area and nearly -2.5% in the U.K. and the U.S. Indeed, the real Japanese short term interest rate is even higher than in New Zealand (about 1%) and Australia (about 2%)

Comparisons of real long term interest rates is less favorable to Japan but even there, its current real 4% yield is higher than in Australia (3.5%) and New Zealand, not to mention the U.S. (1%), the U.K.(1%) and Germany (2%). Only Greece (5%) offers a higher real yield right now.

This makes Japanese bonds look seemingly attractive at this point. For the debt burdened Japanese government the current elevated level of real interest rates is a lot less pleasant. And for this reason, it is likely that the Bank of Japan will at some point use more aggressive measures to halt deflation, which of course would make Japanese bonds a lot less attractive.

Why China Raised Reserve Requirements

5 news items from the Credit Bubble Bulletin that explains why it was necessary for China to again raise reserve requirements (and why this increase probably was too small):"February 11– Bloomberg: “China’s lending surged to 1.39 trillion yuan ($203 billion) in January and property prices climbed the most in 21 months as banks extended more credit in anticipation the government will tighten monetary policy. Lending was more than in the previous three months combined… Property prices in 70 cities rose 9.5% from a year earlier… China’s 9.35 trillion yuan of loans in the past year has added to the risk that the world’s fastest-growing major economy may overheat…”

February 10 – Bloomberg: “China, the world’s second-largest energy consumer, set a January record for crude oil imports as a recovering economy bolstered demand for fuels. Shipments reached 17.1 million metric tons last month…33% more than the year- earlier month.”

February 10 – Bloomberg: “China’s imports climbed for a third straight month in January… Imports climbed a record 85.5% from a year before, a jump that was influenced by a shift in the lunar new year holiday to February this year… Exports rose 21%...”

February 9 – Bloomberg: “China’s passenger-car sales more than doubled in January after the government extended economic stimulus measures… Sales of cars, multipurpose vehicles and sport-utility vehicles increased to 1.32 million units… Total vehicles sales, which include buses and trucks, more than doubled to a record 1.66 million units.”

February 12 – Bloomberg: “China’s January electricity consumption jumped 40.1% from a year earlier as an economic recovery in the world’s second-biggest power producer spurred demand from factories. Power use reached 353.1 billion kilowatt-hours last month, 2.7% higher than in December…”

It is true that some of this extremely rapid growth reflects "Lunar New Year effects" (It's therefore almost certain that growth will be a lot lower in February), but it also reflects very high underlying growth, driven in part by excessively high credit- and money supply growth.

Friday, February 12, 2010

Like Reporting Fahrenheit As Celsius

When European news papers report temperatures in America, they usually don't take the Fahrenheit temperatures and report it as for example "30 degrees" when the temperature is 30 degrees Fahrenheit somewhere in America. That would create the misleading impression for readers, used to the Celsius scale, that it is very hot there (30 degrees Celsius is pretty hot, the equivalent to 86 degrees Fahrenheit), when in fact the temperature is below the freezing point. For the same reason, American media outlets reporting about temperatures in Europe usually don't take the Celsius number and present it simply as for example 20 degrees. That would create the misleading impression that it is cold there, when in fact the temperature is the equivalent of 68 degrees Fahrenheit.

So why then do American media outlets report for example France's fourth quarter growth rate as 0.6% while European media outlets report America's fourth quarter growth rate as 5.7%? For both American and European readers this creates the misleading impression that growth in the U.S. was nearly 10 times higher, whereas in reality it was only about 2.3 times higher. When reporting about European numbers, American media outlets should "translate" them to the American way of expressing growth, which in the case of France would have been about 2.4%, while European media outlets should "translate" the American growth number into the European way of expressing growth, which in this case would have been 1.4%?

For me and many others who are aware of this issue, this is not really a problem, but most people will probably be misled by the failure of financial journalists to not only fail to translate the numbers, but also not inform readers of this issue.

More On Canada

Our Conservative Prime Minister Stephen Harper is an economist by profession and training, and a real fiscal conservative by inclination. During the Sept.-Oct. 2008 general election campaign, he said:

"I think if we don't panic here, we stick on course, we keep taking additional actions, make sure everything we do is affordable, we will emerge from this as strong as ever. We are not going to get into a situation like we have in the United States where we're panicking and enunciating a different plan every single day."

The PM was widely criticized by the opposition parties and the media for the "don't panic" comments. They said that the Government wasn't doing anything about the economy, the tacit Keynesian assumption being that you have to do something. The Conservatives were re-elected but didn't get the majority in Parliament that they wanted.

Shortly after the election, the Government's policies changed. Since "don't panic" didn't poll well, they decided to go in big with "stimulus". We are now bombarded with ads telling us about the federal government's stimulus programs. The result is a projected budget deficit of C$55.9 billion. That's about 4.7% of GDP. So that and the easy credit conditions are the source of the increase of the money supply that you highlighted in your blog.

I think that the Conservatives hope that this "being seen to be doing something" strategy will deliver them a majority government in the general election expected this year. Then, the conventional wisdom is, they can govern conservatively. I believe that the PM knows what he is doing is bad economics, but his political advisors are probably telling him that he can't win a majority in an election if he appears to be doing nothing. Canadians are very conditioned into expecting the government to solve their problems. Then, too, we have a barrage of President Obama rhetoric about fiscal stimulus bombarding us from across the border with the U.S."

Why Hasn't The U.K. External Deficit Declined?

Edmund Conway seems perplexed that the U.K. trade deficit is in fact increasing, despite the weak pound. That it wouldn't immediately drop was perhaps to be expected given the J-curve effect, but by now the effects of the dramatic depreciation of the pound should appear.

There are two reasons for this: One is that Britain have had much higher inflation than in the euro area (With euro area consumer prices rising 2.5% in 2 years, versus 6.1% in the U.K.), meaning that the pound has depreciated less in real terms than in nominal terms.

The second, and more important reason for this pattern, is that the exchange rate is not the only monetary mechanism affecting trade balances. Real interest rates matters as well, with higher real interest rates limiting both domestic investments and consumption and instead increasing net exports. And because real interest rates in the U.K. have been much lower (negative) than in the Euro area, it should not be surprising that the U.K. trade and current account deficit doesn't fall, despite the debased exchange rate of the pound.

U.S. Trade Report Increases Probability Of GDP Downward Revision

The U.S. trade deficit in December was much bigger than most analysts (though not me) and the BEA had expected when calculating fourth quarter GDP. As a result, the fourth quarter trade deficit rose to $109.7 billion, up from $97.3 billion in the third quarter. That implies that trade statistically reduced GDP by about 1.5 percentage points in terms of trade adjusted terms. Because almost the entire increase can be attributed to higher increases in import prices than export prices, the drag on the headline number is likely to be closer to zero. However, that compares with the 0.5% contribution in the initial report.

This means that it is likely, but not entirely certain (because other components may be revised with the opposite effect. But it is also possible that their revisions might have the same effect. The inventory number for example will also likely be revised down), that the GDP number will be downwardly revised.

Tuesday, February 09, 2010

More On Canadian Housing Bubble

"Average home prices in Canada have risen 23% from their trough in January 2009. Home-sales volumes are up 70% over the same period....

....The 2009 price increase of more than 20% came as personal income in Canada fell nearly 1% and total employment was 1.4% lower than the year earlier. In a December report, the Bank of Canada warned that household debt—largely mortgages—was 1.42 times disposable income during the second quarter of 2009, a record high....

....Another possible danger: Because Canadian banks typically reset adjustable-rate mortgages every few years, those who are buying now at low rates will likely see increases soon. Toronto-Dominion Bank forecasts suggest that the rate to which many Canadian mortgages are pegged, the prime rate, could nearly double by the end of 2011. The Bank of Canada warned in its December report that if interest rates increase as expected, by mid-2012 about 9% of Canadian households could have so much debt that they'd be "financially vulnerable....

...In October 2008, the Bank of Canada made the first of a series of rate cuts that eventually lowered the target for its key overnight lending rate to 0.25%, which in turn reduced banks' prime rate—the basis for calculating variable-mortgage rates in Canada—to 2.25% by April 2009. In Canada, nearly all mortgages have rates that adjust at least every few years. Currently, rates on some loans have fallen to 2% or lower.....

...But Canada's central bankers appear reluctant to take any steps that would hurt the economy. In a Jan. 11 speech, a representative of the Bank of Canada said: "If the Bank were to raise interest rates to cool the housing market now…we would, in essence, be dousing the entire Canadian economy with cold water, just as it emerges from recession.""

As a sidenote, I do find the comments by Barry Ritholtz in his post to be somewhat confused. First he links to evidence that Canada is in fact experiencing a housing bubble, but then he proceeds to assume that Canada is insulated from housing bubbles, based on a speech by some Fed official (A speech which not surprisingly was nonsensical as I demonstrated here), as if remarks by Fed officials was more important than the actual facts

Monday, February 08, 2010

The Epistemology Of Economics

A reader (contributor) recently asked me what principles should be used in identifying just what economic indicators one should focus on when analyzing economic events. That was one of the hardest but also one of the best questions I have received.

The reason why it is hard is that there actually is no good answers in the sense of indicators which are always relevant. Some are relevant a lot more frequently than others, but there is no universal indicator which you should always focus on.

The choice of indicators is essentially contextual. By contextual, I mean the indicators most relevant in the context which is discussed. But how do you determine what is most relevant? That depends on what you want to find out, of course. But generally, one should focus on 1)The key causal factor(s) 2) The key present (or immediate) symptom(s) 3) The key likely future (or later) effect(s).

That could potentially mean almost an unlimited number of numbers, but one should "economize" according to an epistemological principle which the reader in question, and probably many others are familiar with:

"concepts are not to be multiplied beyond necessity—the corollary of which is: nor are they to be integrated in disregard of necessity."

For example, with regard to trade, when discussing factors affecting exchange rates, it is rational to simply rationalize away exports and imports and simply use the trade balance. But when discussing effects on real output, a drop in both imports and output is likely to be associated with (and partially cause) a drop in real output.

I can't list in a single post all factors of all three mentioned kinds in all situations, but one example should do: The recent financial crisis in America. What was the causal factors? As a basis, one could use my November 2004 article (suggested by the questioner) predicting the crisis. While my particular choice of indicators wasn't necessarily the best possible, I can say even in hindsight that they were good (in hindsight it probably wasn't the best possible, but it was still good). As an example of how indicators should be chosen, it will do.

The causal factor behind the housing bubble was the low interest policy pursued by the Fed.

This created the housing bubble whose immediate consequences included higher house prices, higher level of construction spending, higher levels of household debt, a bigger current account deficit, and a higher private sector financial savings deficit.

The later effects included a retreat from the excessively high levels of house prices, household debt, current account deficits and private sector financial deficits and an unsustainably low household savings rate. And since there are rigidities in the real world economy (both in the form of price rigidities and the difficulty in many cases of using workers and capital equipment for new tasks) this will ultimately mean that employment and the real value or output will decline.

Going through the different indicators,it can be asked why were they chosen:Starting with initial interest rates it is an indicator directly controlled by the central bank.

What about the indicators of immediate consequences: Since houses are mostly a capital good, and since the present value of capital goods (which by definition generates its value at a later point in time) increases when interest rates (the price of time) goes down, it follows that house prices should increase. And since house prices are relevant for both the profitability of house construction as well as the willingness of home owners to take on additional loans this is clearly an indicator relevant for economic analysis.

Another relevant data was the dis-aggregation of household asset and data values, pointing out that while many households had big assets and almost no debts, others had limited assets and debts almost as large as their assets, making them highly vulnerable for asset price declines.

I also mentioned as a factor driving the boom, the shift from a budget surplus under Clinton to a large deficit under Bush. While this wasn't related to the housing bubble, it wasn't a sound source of demand. Another factor I mentioned was the purchases by Asian central banks of U.S. Treasuries. That wasn't however meant to represent a causal explanation of the crisis, instead it explained why the bubble persisted even though money supply growth in 2004 had moderated compared to the high levels of 2001-02. Since the absence of these purchases would have likely been associated with higher money supply growth, it wasn't really a causal explanation though.

In short: the key is to focus on the indicators that are most relevant for causing a certain event, the indicators that best reveal the existence of a certain scenatio taking place right now, and the most likely relevant effects. And when chosing indicators in these 3 stages use the "Rand's razor" to achieve understanding of what is going on.

Saturday, February 06, 2010

Labor Mobility & Currency Unions

Particularly when American opponents of the European Monetary Union (EMU) claims that the problems of for example Spain or Greece proves that the monetary union is a bad idea, many people point out that their argument could be used to argue that for example California or Florida should ditch the U.S. dollar and introduce their own currencies. Since virtually no American critic of the EMU is arguing that California or Florida should stop using the U.S. dollar and introduce their own currencies, many suspect that their critique is based on the resentment of any other currencies challenging the U.S. dollar's "reserve currency" status.

Anyway, regardless of what motives American critics of the European Monetary Union may have, it is obvious that California in particular have fiscal woes very similar to Greece's and have had a more severe housing boom and bust than the U.S. average, just like Spain had a more severe housing boom and bust than the Euro are average. And since California would in fact in terms of GDP represent the sixth largest currency zone in the world (after the U.S., the Euro area, China, Japan and the U.K.), it would seem that they could do better than most with their own currency.

One of the most prominent and most passionate American EMU opponents, Paul Krugman, answered that there are two reasons why it makes more sense for Spain or Greece to have their own currencies than California or Florida. First, the United States have fiscal federalism (a federal budget that redistributes between regions) while the Euro area does not, and secondly because labor mobility is much greater within the United States than in the Euro area.

The fiscal federalism argument is true in the sense that while the U.S. has a large federal budget (larger than ever these days), the Euro area itself has no budget and the EU budget is very limited in size (only slightly more than 1% of GDP). Also, it is probably true that a common budget reduces regional differences in cyclical development. That however doesn't necessarily mean that it benefits overall growth since it in effect punishes the more successful regions and rewards the more failed regions, something which in turn harms growth.

And from a pro-capitalist/libertarian point of view, the absence of fiscal federalism is in fact something positive since it enfeebles the state. If the state can't print money at will, this reduces their power to spend. While the European Monetary Union differs in important aspects from the classical gold standard, it is similar to the gold standard in the sense that it disables the state from spending by the direct or indirect use of "the printing press".

And moreover, if the absence of fiscal federalism made a monetary union untenable, then that would have indicted the United States before the 1930s. Before Herbert Hoover and Franklin Roosevelt dramatically expanded the role of the federal government in the United States in the 1930s, federal spending on domestic (as in non-military) items was no greater than the current EU budget relative to GDP.

"But labor mobility was much greater then" someone might say. Indeed it was. The absence of a federal welfare state in the pre-Hoover era caused labor mobility in the United States to be much greater than not only in the present day Euro area but also compared to present day United States.

But, labor mobility will in fact likely increase rather than decrease regional differences in business cycles, as a larger number of people in growing regions will increase growth there while a smaller number of people in weaker regions will further reduce economic activity there.

It could justifiably be objected that reduced regional differences is not really a self-end and that the key is that overall output will be maximized and overall unemployment will be minimized. Assuming that differences in growth depends on other sectors than the housing sector (or some form of government distortion), higher labor mobility will indeed increase growth and reduce unemployment for a region.

But, as I already hinted in the previous paragraph, this might not hold if the cause of regional differences is a housing boom. The reason for that is that while immigration during booms and emigration during slumps increases and decreases respectively the supply of labor in accordance with the movements in demand of labor, immigration during a housing boom will temporarily further increase housing demand and so help worsen the bubble. Similarly, if foreign (or domestic) workers leave during housing slumps, this will further reduce demand for housing and increase the gult of unsold homes and cause further declines in construction activity.

During the housing boom of these countries, both Spain and Ireland in fact had a massive influx of foreign workers, many of whom worked in the construction industries, something which helped fuel an already unsustainably high level of housing construction activity (as these new workers of course wanted some place to live and so increased housing demand). Now particularly Ireland, but also Spain, are experiencing net emigration of workers, something which will further increase the crisis in the housing sectors in those crisis. And the story is pretty much the same in American states with particularly large housing bubbles, such as California, Nevada, Arizona and Florida.

Whatever the pros and cons of increased labor mobility in other situations, it seems clear then that it does not reduce the economic costs of regional housing bubbles, and that it is therefore not as important factor as Krugman and others claim in determining what is "optimal currency areas".

What's Behind Asia's Growth?

His theory isn't false, but not specific enough and he doesn't really explain how come most Asian governments have interfered in business life in various way (It's really only Hong Kong have pursued a laissez faire industrial policy, which is to say none at all)and yet growth have been strong there too.

As the success of Hong Kong's economy illustrates, these policies were not behind growth. At most, growth in other countries only proves that they have not had a significant negative effect, not that it was positive.

What then is behind Asia's rapid growth? Well, there are two key characteristics that the Asian countries share, and which on theoretical grounds can be shown to increase growth:

-Very limited welfare state spending. This is the key "free enterprise" principle of the Asian economies.-High rates of savings and investments.

The latter is in part a result of the former, but also probably a result of cultural attitudes.

For the poorest countries, another factor, namely the so-called "catch up" factor is also behind growth. The "catch up factor" results from the implementation of foreign technologies and increased trade with more advanced economies, allowing poor countries to grow faster than more rich countries, and it also allows them to grow faster than today's rich countries when they were at the same income level. However, in order for the "catch up" factor to work, there must be other factors fueling growth. If not, then it will not appear, and poor countries will slip behind further, as is the case with for example most African countries. This is similar to how you get a bigger fire when you pour gasoline on it, but if there is no fire to begin with, gasoline won't create any fire.

Friday, February 05, 2010

The Employment Report-Jobless Claims Discrepancy

January's U.S. employment report was in many ways very similar to the November employment report. A small decline in jobs according to the payroll survey, but with other indicators suggesting growth, including a significant increase in average weekly earnings and a big jump in employment according to the household survey.

This supports the view that the U.S. economy is growing moderately right now.

What is worth noticing is however that this report is inconsistent with the reports of growing number of people receiving unemployment benefits (including extended benefits). Compared to a year earlier, the total number of people receiving benefits have risen from about 7.6 million to 11.5 million, while the total number of unemployed is up less dramatically, from 11.9 million to 14.8 million. The number of unemployed without unemployment benefits has thus dropped from 4.3 million to 3.3 million. As a share of the unemployed, people with unemployment benefits rose from 64% to 78%. And while the number of unemployed fell the latest month, the number of people receiving unemployment benefits rose.

What is going on here? Because jobless benefit numbers are based on actual payments while the unemployment numbers are based on the less reliable method of interviews in the household survey, one part of the explanation is probably that the survey number underestimates unemployment for the latest month. The far weaker number from the payroll survey suggests that this is part of the explanation, at least with regard to the latest month's change.

Another explanation is that Congress have made the unemployment benefit system more generous meaning that people who by now would have lost their benefits in the past still have them now.

A third explanation is the one that Obama economic advisor Larry Summers suggested before he became advisor for Obama: the more generous conditions means that people with benefits are less motivated to get a job, causing the number of people with benefits to increase. Once they lose their benefits however, they are willing to take even jobs that they would prefer not to have because they think pay is too low or because they don't like the tasks that certain jobs consists of, causing the number of unemployed without benefits to drop.

Thursday, February 04, 2010

Bears Finally Taking Charge?

I'm not sure, I've given up on short term market timing. But it does seem more likely than not. And more importantly, given the elevated valuation levels and the high probability of a double dip recession, it seems clear that stock prices should fall on fundamental grounds.

"he[Obama] says he wants to end "tax breaks to companies that shift jobs overseas". In preparing this post, I tried to find out what that means. Has Congress passed a "Tax breaks for companies that shift jobs overseas Act"? No, of course not. I am still not completely sure as to what, if any, tax code this refers to, but I think he means the provisions in the U.S. corporate tax code that is designed to prevent double taxation of profits by foreign subsidiaries of U.S. multinational companies.

This kind of practice exist almost everywhere as it otherwise would put a country's multinational companies at a great disadvantage, having to first pay corporate tax in the country it operates in, and then in the country where it is headquartered. This practice means first of all that foreign profits aren't taxed until it is repatriated to the country where the company is headquartered and secondly that a company can deduct taxes it has paid offshore so as to avoid double taxation. If that is what he means by "tax breaks that shift jobs overseas", then doing away with that would greatly damage American multinational corporations, and so also lower stock prices. This together with a proposed "tax credits" for companies that increase domestic operations relative to foreign might perhaps increase the willingness of American companies to move foreign production to America, but the main effect would be to simply damage the competitiveness of these companies as they are forced to choose production alternatives which are less competitive. And as they in effect amount to tariffs on products produced outside America by American companies, they will damage the global economy as a whole and the rest of the world."

Wednesday, February 03, 2010

Is Macroeconometric Modeling Fraud?

Arnold Kling points out that macroeconometric models could be viewed as being fraudulent given how they falsely claim to know that a certain policy will create for example 640,329 jobs. In reality, you can't know these things, particularly not with the precision that macroeconometric models claim to represent.

Strictly speaking though, it is not so much the models themselves that are fraudulent, but the assertions of its practitioners to represent scientific precision that are fraudulent, just like -to use Kling's analogy- it really wasn't the quack medicines that were fraudent, but the assertion of its sales men that they would cure diseases.

Monday, February 01, 2010

Inventory Hangovers

"Since 1970, there have been nine quarters, like the last one, when GDP grew by at least 3 percent and inventories accounted for at least half of that growth. The history of those quarters is hardly a favorable sign of what is in store.

Inventory spikes make for blowout quarters. In the nine quarters with such spikes, the average growth rate was 6.6 percent and the average inventory contribution was 4.4 percent, even higher than what was observed for last quarter.

Spikes also produce hangovers. The average growth rate in the quarter after a spike was 0.9 percent, a whopping 5.7 percent lower. In the second quarter following a spike, the average growth rate is just 1.6 percent."

Since inventories was still actually decreasing in Q4 2009 (only at a far slower rate than in Q3 2009), this "hangover effect" will probably not come in Q1 2010. Instead it will come later in the year.

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